The New Keynesian Phillips Curve in a Small Open Economy: Empirical Evidence from Australia

Abstract

This study estimates the new Keynesian Phillips curve (NKPC) of Gali and Monacelli for a small open economy using Australian data. Our detailed investigation hinges on estimating the structural parameters in five different variants of the Gali–Monacelli NKPC, which relates the inflation process to terms of trade and the real exchange rate; the marginal cost and output gap as proxies for real economic activity and the hybrid version incorporating both forward‐ and backward‐looking inflation expectations. The analysis and extensive robustness checks overwhelmingly establish that the Gali–Monacelli NKPC cannot explain the dynamics of inflation and is rejected by the Australian data.